States Brace as Supercommittee Targets $500 Billion in Aid

“We need money,” California Governor Jerry Brown, a Democrat, said this month. “The state is facing a national economy that may go into another recession, a great retraction, and the people in Washington are cutting back even more.” Photo: Justin Sullivan/Getty Images

Sept. 19 (Bloomberg) -- In statehouses across the U.S., a
budget-cutting congressional supercommittee and the sputtering
economy threaten a fledgling recovery from the worst fiscal
crisis in more than 70 years.

Stalled job growth, eroding consumer confidence and a stock
market that has lost more than $2 trillion since April may cut
into tax collections that have yet to fully rebound from the
recession. At the same time, Washington policy makers are moving
to slash federal spending, a potential threat to dozens of
programs -- from Medicaid and school-lunch subsidies to defense
contracts and law-enforcement grants -- that nourish state
budgets and local economies.

“We need money,” California Governor Jerry Brown, a
Democrat, told reporters in Sacramento this month. “The state
is facing a national economy that may go into another recession,
a great retraction, and the people in Washington are cutting
back even more.”

With the debt-cutting supercommittee debating ways to shave
$1.5 trillion from U.S. spending over the next decade and some
in Washington calling for cuts of even more, states are dealing
with an added source of concern: Just how much of the
approximately $500 billion they receive from the federal
government each year may disappear?

Tax-Exempt Bonds

President Barack Obama has added to that concern with his
$447 billion plan to stoke the economy and his recommendations
to the supercommittee today. While offering funds for states and
localities to stem job cuts, Obama has also proposed scaling
back a tax exemption for municipal-bond interest -- something
that could raise borrowing costs.

Obama also proposed changes to Medicaid, the jointly funded
health-care program for the poor. Among them is a step to cut
federal spending by $26.3 billion over 10 years by limiting a
tax technique states use to reduce their share of the costs.

Public officials are trying to figure out how to prepare
for federal cuts or a recessionary relapse.

In Virginia, Republican Governor Robert McDonnell is moving
to set aside cash to cushion the impact of budget cuts in his
military-heavy state. Tennessee agencies are readying plans to
cope with losing as much as 30 percent of their federal funds.
And in California, Brown, 73, says the stalled economy could
force deeper cuts to cash-strapped schools.

Wall Street Watching

On Wall Street, analysts are also watching for any strains
that could affect the value of state and local government bonds,
a $2.9 trillion market.

“The weakening of the economy is going to have a more
immediate hit, but I think the focus of the market is what the
12-person panel does over the next few months,” said Chris
Mauro, a municipal-debt investment strategist for RBC Capital
Markets in New York. “Investors shouldn’t think the worst is
behind us.”

For now, states are reporting rising income-tax receipts,
and the trend may continue if concerns that growth will stall
prove unwarranted. Helped by the economy, state budget gaps are
expected to drop to $32 billion in the next fiscal year, about a
third of the level for the current one, according to the
National Conference of State Legislatures in Denver. Any
congressional moves also may spare states immediate pain.

Still, only three months into fiscal 2012 for most states,
there are signs of worry. “They all would say close to the same
thing, which is, ‘We’re concerned and we have to watch,’” said
Scott Pattison, executive director of the National Association
of State Budget Officers in Washington.

Delayed Effect

State tax collections lag behind the overall economy, so
any shift wouldn’t show up for months. State receipts peaked
during the height of the financial panic in September 2008,
about 10 months after the recession began, and didn’t begin
rising again until the first quarter of 2010, some six months
after its official end, according to U.S. Census Bureau data.
Even with gains since 2010, helped in part by tax increases,
state revenue has yet to climb back to its peak.

On Sept. 9, the chief economist for Florida’s Legislature
said the state’s recovery will be “significantly” slower than
forecast, raising the prospect that budget deficits will
reemerge. The same day, California Controller John Chiang said
state revenue trailed budget estimates by about $404 million two
months into the fiscal year.

State Cuts

Indiana Governor Mitch Daniels’s administration this month
said that it expects slowing economic growth to cut several
hundred million dollars from projected state receipts during the
next two years. In neighboring Ohio, Governor John Kasich has
said he’s ready to cut spending again if revenue slows.
Washington state, reliant on sales taxes, last week cut $1.4
billion from its revenue forecast through fiscal 2013.

“Global economic uncertainty, new data on national output
and the stalemate in Washington, D.C., have slowed the outlook
for economic activity significantly since our last forecast,”
Arun Raha, the chief revenue forecaster for Washington state,
said in a statement. “Our reduced revenue estimates today are
troubling, but not surprising.”

States with economies closely tied to the U.S. government,
through military bases, direct employment, or large numbers on
federal assistance, may face added strain.

In July, Moody’s Investors Service told Virginia, Maryland,
South Carolina, Tennessee and New Mexico that they may lose
their Aaa general-obligation debt ratings because of the fiscal
turmoil in the nation’s capital. Today, Moody’s said it is
keeping a negative outlook on the credit ratings of U.S. states
as a whole, citing the twin challenges posed by the economy and
a debt-averse federal government.

‘No One’ Spared

“No one can be spared from the pain of the overspending,
over-borrowing and overtaxing by our government under
Republicans and Democrats,” New Jersey Governor Chris Christie,
a Republican, told reporters this month. “Am I concerned? I’ll
deal with whatever comes. I would be much more concerned if they
didn’t deal with this problem because that is going to be more
destructive for my children and grandchildren.”

Congress is moving toward cutting as much as $2.4 trillion
over the next decade, a result of the comprise Obama struck with
Republicans in exchange for allowing the federal government to
borrow more money. The initial phase, which will save $917
billion by limiting spending growth, spared states by holding
spending nearly steady in 2012. How that is to be done, and how
it bears on dozens of state and local programs, hasn’t been
specified.

Broad Mandate

The congressional supercommittee of 12 lawmakers, split
evenly between Democrats and Republicans, has a broader mandate
for finding $1.5 trillion more through any mix of spending cuts
and revenue change they can agree upon. If they can’t agree on
at least $1.2 trillion in savings, automatic cuts of that amount
would be triggered, and half would come from defense.

Some states have reason to root for that outcome. If no
agreement is reached, some $364 billion headed their way would
be exempt from such cuts, including money for Medicaid, some
roadwork and cash assistance for the poor, according to Federal
Funds Information for States, a service of the National
Governors Association and the National Conference of State
Legislatures. About $133 billion in other aid could be cut,
including cash for education programs, rent support for the poor
and homeland security grants, according to the service.

There’s no way to say precisely how deep the effects will
be, though cuts are inevitable, said Michael Bird, a Washington
lobbyist for the legislatures group.

Bracing for Pain

“There’s no way to prevent this,” he said. “It’s going
to happen.”

Few places have more at stake than Representative Scott
Rigell’s district in Virginia Beach. Nearly half of the economy
in the coastal region known as Hampton Roads, which spans the
state’s southeast, is generated by military bases and contracts,
making it vulnerable should the stalemate in Congress prevail.

Nevertheless, Rigell, a Republican who was first elected
last year, said the threat of a national fiscal crisis from the
spiraling debt was a greater concern.

“It’s putting the foundation of our country at risk,” he
said. “If each and every person brings to Washington a
parochial mindset that never, never in my district should we
experience any pain, then we’re in for a very difficult time.”

States are facing their own difficult times, even without
additional stress from the nation’s capital. They’ve cut 130,000
jobs since state employment peaked in August 2008. Since the
last three months of that year, when revenue began sliding,
budget-cutting state and local governments have exerted a drag
on the economy in all but two quarters.

Illinois Jobs

In Illinois, the cuts aren’t over. This month, Governor Pat
Quinn, a Democrat, said the state will dismiss 1,900 state
employees to avoid a partial government shutdown early next
year. The state is short of cash even though it raised its
personal income-tax rate by 67 percent in January.

In Colorado, Governor John Hickenlooper also sees no easing
to the pressure on his state.

“We know we’re going to have a difficult budget year,” he
told reporters this month. “We’re not looking for a bailout
from the federal government. We’re not going to buy our way out
of this recession. We’re going to have to grow our way out.”